The UK Government has taken the first tentative steps towards a solution to this crisis with its decision today to give stressed borrowers an interest repayment holiday of up to two years (New scheme to help people at risk of repossession).
The scheme is limited in scope to households that suffer ”a significant and temporary loss of income as a result of the economic downturn to defer a proportion of the interest payments on their mortgage for up to two years”. It also guarantees banks that the deferred payments will ultimately be made.
This is a step in the right direction–towards ultimately debt moratoria. It isn’t enough–because the interest will still be compounded–but it does make the important point that the accrual of interest on debt can be tampered with by legislative means as well as by economic ones.
I favour the legislative approach–which should ultimately include debt moratoria, or a revision of this scheme which involves no accrual of interest and repayments therefore reducing outstanding principal–because I don’t believe the accepted economic approaches to reducing the real debt burden will work.
The standard economic means to reduce the debt burden is to “print money to cause inflation”. Ben Bernanke himself is famous for the following remark:
If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation. (Bernanke, Deflation: Making Sure “It” Doesn’t Happen Here)
I have little confidence in this mechanism. It is predicated on a Monetarist theory of money, in which, to quote the Godfather, “Inflation is always and everywhere a monetary phenomenon” (Milton Friedman, A Monetary History of the United States 1867-1960). It is possible to substantially agree with this argument and still argue that government printing of money won’t cause inflation–because Milton Friedman’s “model” of money completely ignored the existence of credit money.
Here is Milton’s model of money creation and how that engenders inflation:
Let us suppose now that one day a helicopter flies over this community and drops an additional $1,000 in bills from the sky, which is, of course, hastily collected by members of the community. Let us suppose further that everyone is convinced that this is a unique event which will never be repeated…
… When the helicopter starts dropping money in a steady stream … it takes time for people to catch on to what is happening… As people catch on, prices must for a time rise even more rapidly, to undo an initial increase in real balances as well as to produce a long-run decline… (Friedman, “The Optimum Quantity of Money”, in THE OPTIMUM QUANTITY OF MONEY AND OTHER ESSAYS, pages 4-5 and 13)
IF a helicopter flying over the land dispensing largesse (otherwise known as the Central Bank creating M0) was the only manner in which money could be created, and IF there was no private debt, and IF the economy was in long run general equilibrium and prices prior to the helicopter drop were therefore equilibrium prices… then this approach would work.
Yeah, right…
Instead, in the real world in which we live, financial institutions control the creation of money, private debt is at unprecedented levels, and the global economy is rapidly transiting from a far-from-equilibrium debt-financed boom into a far-from-equilibrium debt-induced crash in which the price of everything is totally out of whack.
In this world, government creation of M0 will be sent straight to the banks to reduce debt levels. The impact on turnover of goods and therefore prices will be minimal. Deflation will continue, and could do so for years as the government effectively swaps base money for credit money–only to see the absolute money supply drop. This was the Japanese experience.
Ultimately, I expect that the failure of the economy to respond to this Friedmanite tonic will result in a profound shift in politics, in which the unthinkable today will become policy: that much of the debt that the financial sector issued especially in the last two decades should never have been created in the first place, and it should be abolished–in conjunction with substantial reforms to financial assets that prevent a similar debt-bubble in the future.
We are still a very long way from that change in consciousness, but this move by the UK government is a first step towards it.
Hi Steve,
In some ways the debt moratoria policy is the same as the helicopter drop. To show this point I have to assume we are in the beginning stages of deflation and that it will worsen. I don’t think either policy will fix the underlying problem. That is, Rising risk aversion and rising private debt reduction. The debt reduction is good in the long run but painful while it occurs. BUT IT MUST OCCUR!!
Eg,
Person A loses their job in the UK and can’t pay their loan. They get an interest holiday and the government guarantees the loan. As deflation takes hold more people lose their jobs. Remember deflation occurs as demand continues to fall and risk aversion rises. Now fast forward 2 years. Person A has less chance of finding a job now, because unemployment has skyrocketed as the deflation continues. Now the government has to pay up (the helicopter just arrived in two years). At this point does the government give up on this strategy or keep putting more money in. My guess is the government gives up because by then they believe like everyone else that they must reduce debt not expand it. Keynes is discredited and the world moves on!
Debt rises under this and the helicopter strategy, not falls. Would have been far better for Person A to have defaulted and the loan written off than to allow the debt to keep growing. While ever debt is rising the crunch is just put off to the future.
At least under the helicopter scenario private debt falls and depositors get some of their money back.
Then Steve you alluded to the idea of legislating that interest can’t be charged. That idea is dynamite. That would cause the collapse of the entire banking system over night. The run on the banks would be massive as depositors would want their money out if they were to earn no interest. But of course the money is not really there, so deflation accelerates.
Steve Keen is predicting housing prices to fall 40% and interest rates to go to zero.
So if say the average house price is $450k then property has to fall to $270k.
Then he predicts by 2010 interest rates will be zero.
So the average bank loan will be 2% above the RBA so we can now borrow $270k @ 2% which is $5400 interest per annum.
That equates to $450 per month repayment.
Well the generous Australian welfare system pays $449.50 per fornight for a single person.
I dont know what you are teaching these kids at UNI professor but BS comes second to facts.
A debt moratoria?
Wow what a bizzarro world it is.
Punish those people for borrowing too much for something they knew they could never afford……..only then will they learn from the mistake.
So? If deflation persists, and people use all their “helicopter drops” to pay down debt, surely central banks can keep printing more money until all debt has been paid off.
This may well result with runaway inflation at the end of the process, but I fail to understand how deflation can’t be solved by printing money. Its just a matter of how much you need to print. Its not like it costs any more to print a $1,000 bill than a $100 bill.
Think I will trust Steve’s take on this Lasty over your call. I also think your assuming a limitless supply of cash and that their would be finance available and willing buyers with jobs etc… I am no economist but then again neither are you from what I have read. (mind you I would suggest buyer/reader beware there!)
Can you show us the model for your analysis it seems a bit simplistic to me?
@’lasty’=> If I was told in ’07 that fuel, the All Ords, Rio Tinto the Australian Dollar & Interest Rates (among others) where to drop by 1 to 2 thirds in value, I would have told them they were dreamin.. but it has happened.. along with massive financial devestation in the USA.
If something seems profound or unbelievable, that on it’s own, doesn’t make it less possible.
Regarding your example.. Well, in Japan interest rates are near zero and rental returns high, so why doesn’t everyone buy a place? Because property has lost value for almost 17 years straight leaving many to paying off debt on something now worth a fraction in value.. among other reasons.
I accept the idea that the huge amount of debt on issue can’t be repayed without dire consequences, but I wonder how the moral hazard of debt moratoria can be handled. Surely if it is known that debt will be written off then it removes any restriction on people piling up assets. A forgiven debt is then essentially a free purchase. I am sure this could be gotten around with subtle legislation, but I wonder how it is recommended this should be done?
Hi guys,
You might want to check out http://au.messages.yahoo.com/finance/finance_news/7969/ regarding Lasty and his comments on other message boards on Yahoo. He is one of the investors who is nervous and sweating it out. He has no model only 2 cents comments that house prices should go up and up and up, salaries have increased, cost of building has gone up, australia has a shortage of housing, australia wont have a recession because of China, interest rates have fallen and people are cheap asses dont want to pay higher prices when wages have increased.
He is not worthy of a discussion or does not have the intellectual capability of having an valid discussion based on real economic data, models or facts. All that he is a Steve Keen Basher/Brickbat and all that he does is post other columinist articles to justify his opionions on Steve.
I have posted my refubbs of him and his mate who endorses his baseless arguments.
What kind of an intelligent guy quotes journilist articles that does not have any economic basis or knowledge as a validation that he is right?
Hi Dojufitz
Brother I feel your pain. My partner and I borrowed less than 2 x our annual income to purchase our house so that if one of us lost our job or interest rates returned to Paul Keating like levels we could afford it. We too will be annoyed that we borrowed rather prudently and those that didn’t get bailed out. Oh well.
I saw in the paper recently that a couple on a gross income of 130K plus kids borrowed for a million dollar home. OMG! I hope that scheme is relatively sensible in that some sort of assessment process is implemented in that the loan compared to income is looked at but I am betting that it won’t. And I agree with comments about in regard to what will those people have learnt? And shouldn’t they learn those lessons?
Unfortunately debt moratoria is one of the steps that has to occur because where will the displaced stay? Do we really want them them staying in parks and cars? And it is cheaper for the government to bail them out rather than build new housing which is what I think that they should do. But, and now we enter my area of excellence, what economists do not take into account is societal reaction to that.
We have seen the reaction to the bank bail outs. I will follow with interest the British reaction to the the public bail out. When the stimulus package was announced by Rudd all the comments were extremely negative. There is a very angry society out there and I am genuinely concerned about the reaction.
There are some angry people out there. Am I am betting that we are close to a violent reaction.
A debt moratorium may give you time to find a solution, but it is not a solution. The problem is too much debt, in every corner of the economy, and there are only so many ways to fix that: discharge, default, inflation or devaluation.
Trying to discharge debts as they come due will cripple households and businesses for years, and bankrupt many. Defaulting the debts will kill the banks and other lenders. Inflation sounds like the answer, but (a) how do you inflate when the banks won’t lend? and (b) it probably won’t work if the lenders have time to prepare (see Roubini).
That leaves devaluation. It worked in 1933, because it was sudden and unexpected. The alternative is years of stag-deflation, something like Japan.
Check out the chart on the Baltic Dry Index (cost to ship commodities). Its well known to be a leading indicator of future commodity prices. The massive drop in the chart index is pretty scary and strongly supports the future deflation theory.
I agree 100% with bull turned bear. I think the problem in Japan is that they issued debt (unfortunately their constitute said they have to) instead of just printing money. I think the trick is to spread the money widely and keep doing it (not everybody is debt, why should those in debt get help but nobody else). And surely, replacing debt with base money is EXACTLY what we should want to be doing, if excessive debt is the problem.
Read this excellent parable from Paul Krugman for an understanding and discussion of this issue:
http://economistsview.typepad.com/economistsview/2006/05/babysitting_the.html
Oops
should read … (unfortunately their constitution said they have to)
P.S. I think is basic right with his analysis, I just think he is incorrect with his policy conclusions. Japan by issuing bonds removed as much money as they added, by giving cash rich individuals a safe interest paying investment in deflationary times. They should have FORCED them to make real investments.
…
I think Steve Keen is basically right…
Proof read (hits head) Proof read (hits head again…)
carbonsink,
Yes, the Central Banks are now printing money.
It won’t be inflationary for the following reason.
1. Debt money (broad money) is being destroyed far faster than the Central Banks are printing. The Fed even with all their printing have not made any impact on the debt deflation that is taking hold.
2. The money that is being printed is being hoarded by the banks.
3. The velocity of money has collapsed.
4. The Central Banks are simply replacing debt money (broad money/M3) by base money (M0), and the base money is being hoarded by the banks that simply keep as reserves held with the Central Bank. So in reality the money supply is simply collapsing slower than it would have if Central Banks were not to expand their balance sheet.
5. Central Banks would have to be very weary of not having investors loose confidence in their currency. Such a gambit of “forever printing” if perceived by the capital market is fraught with high risk that would precipitate currency collapse and complete economic destruction.
Steve,
I’m just an engineer – not an economist although I’m trying to educate myself a bit in light of recent events so here goes.
Your points about debt make a lot of sence to me. It occured to me when I first started looking at housing two years ago (was looking at buying based off of my parents parreting the whole – ‘only go up – get on the ladder’ mantra) and I discovered the crazy price/income ratio’s (demographia report was best summary I found) and so have rented. It seems though that it’s not just house prices but debt/income (GDP) in general that’s gone bezerk.
However, what I don’t understand is why it necessitates a deflation.
I get the idea – the historic ratio must be restored for long term stability; but doesn’t this either mean the debt has to come down (by a cut in spendings – ie deflation) OR the income goes up through an inflation.
I also get the idea that right now we’re in a bit of a race with the printed money being horded and that its the velocity of cash that’s the issue. However, there’s no (as I understand it) limit to the amount of $$$ the fed can print.
Therefore, why can’t the fed just add up all of the debts in the economy and just issue that amount of money. Hey presto – no more debt. Massive inflationary kick in the tail though…
Surely with an infinite supply on tap hoarding by definition MUST stop at some point (ie once every single debt is repaid)?
For consumer debt example, the govt could just order every home loan in the country bought up with a govt loan which it then securitises into one giant package and sells to its own fed. No more debt and a huge amount of extra money – ie a stagflation. (or am I missing something – most likely I’ll happily admit)…
Oh – and Lasty, I might not be an economist but aren’t you forgetting paying back the principal???
After all, the cost to rent the money from the bank to buy the asset isn’t the only cost!
There’s the cost of the asset itself (currently median = 8.5 times median HOUSEHOLD income in Sydney) + stamp duties + legal fees + maintenance.
Then of course what happens when interest rates go back up? Or do you think they’ll stay at 0% in an inflationary environment (ie the world of your rising house prices)?
To give an idea of the stupidity of the principal amounts alone, consider that at 8.5 times the gross annual income, with a 30% tax rate and a 30% of net income budget for repayment, the principal will take a tick over 40 years to repay at 0% interest (obviously this is extremely crude).
i = income
8.5i = principal
i x 0.7 = net income
0.3(0.7i) = repayment budget (30% of net)
therefore t = 8.5/0.7/0.3 = 40.47 years
Planning on working for a while are you Lasty?
Iconoclast is pretty much “on the money” here. I’ll leave a complete elaboration as to why until my next Debtwatch–which has the working title of “The Money Makers”–but the basic problem is that the scale of fiat money creation is far smaller than that of private reductions in debt, and therefore reductions in circulating credit money.
Added to this is the neoclassical economics obsession opposing government deficits, which has in Japan led to them insisting that all fiat money creation is financed by issuing government bonds rather than simply “printing money”.
Finally there is a real economic dilemma, even if hyperinflation were triggered (or debts were reduced by fiat–moratoria seems to be a confusing term, so I’ll go for debt reduction instead in future). This is that a huge slab of aggregate demand was debt financed, and that fraction disappears even if monetary inflation works.
In the USA, the increase in debt was responsible for about 27% of spending; in Australia it was about 20%.
To make up for that, we have to generate aggregate demand from another source–and the only sustainable source is income (GDP), not more debt. But that has to be based on a productive capacity we no longer have. It will instead have to be built up over time, and that ensures a real economic slump in the interim.
Dicko:
I’m (software) engineer, not an economist as well, and I agree with your comment:
Steve and iconoclast have given very good reasons why this won’t happen, but (IMO) no-one has adequately explained why it can’t happen. Especially if deflation becomes an intractable problem, policy makers become desperate, throw caution to the wind and abandon all their neo-classical principles.
You could argue that Bernanke and Paulson have abandoned most of their principles already!
Hi Reason
I read your link and I am surprised you did not see the obvious due to the author failing to acknowledge what underpinned the process in the first instance, and then flippantly skipping the problems that arose when the co-op issued script in complete contradiction to its founding principles. In fact the example used in the article only re-enforces Steve Keen’s views on printing money.
Firstly the babysitting script was only issued after it was earned by actually doing an hour’s babysitting for each script given, which was issued by the recipients of the service. The reason a shortage of script occurred was not due to a lack of script but a lack of productivity due to a lack of demand. The productivity produced was in exact keeping with the demand required. The scripts worth was only as valid as the principles it was issued – do the time get the dime as it were. The author neglected to expand on the problems that happened when they moved from the productivity reward system to printing script and then circulating it arbitrarily without the production side directly maintaining its value. The scripts value was in the fact you were legitimately owed babysitting hours by those of whom you had provided the same service. The new system they created, by issuing script without a couple first earning it, meant the co-op had to underwrite its worth by somehow forcing those in the co-op to provide time, even if those in the system had not used any babysitting time themselves.
In short the new system would never have worked because script was not being issued on productivity output, or formulated on production capacity, but rather on peoples wants with the promise they would pay in the future. The more script that was issued the more all co-op members had to pay – and what happened? It fell over. When the author of the articles finished his extract with “Eventually, of course, the co-op issued too much scrip, leading to different problems …” and didn’t bother to explain the different problems he conveniently avoided discussing the very problems associated with monetary systems of this type. Bottom line – the script became worthless because too much was issued and was no longer able to be supported by the co-op through actual productivity produced by actual babysitting hours. And here in lies the basic problem of printing money not based on productivity output or realistic future capacity. It doesn’t work!
As I said the story only confirms the very points Steven Keen has been making.
Carbonsink,
back in 1956 during the Suez crisis, the British & French were not prepared to accept Nasser’s position regarding nationalisation of the Suez Canal. The French and British had developed a plan to seize the canal by scheming with Israel to create a casus belli, where Israel would under the pretext of an Egyptian-sponsored fedayeen attack against Israel, were to invade the Sinai Peninsula and approach the Canal. The Israeli forces invaded after which a force from UK and France entered the Canal zone.
Eisenhower, however, had no idea of this plan. Furthermore, Egypt was supported by the Soviet Union. The U.S. government demanded that Israel, UK and France withdraw immediately, given the consequences could have quickly escalated out of control.
The British, being a debtor nation, and the U.S. being the hold of British debt, used Financial warfare to force the British to withdraw. Where the U.S. effectively threatened to destroy the British currency and thus destabalise their economy.
The British backed down and withdrew their forces.
Fast forwarding into the future, the U.S. is now the debtor nation and China, Japan, and the petro-states of the middle-east are the creditors.
If the U.S. attempts to inflate their way out of this, these creditor nations will certainly extract their pound of flesh.
Treasuary secretary Paulson has already flying over to China and have numerous discussion on their current financial predicament.
The Chinese have stated publicly, that they expect that the U.S. will do all it can to protect the investments of the Chinese people.
The Chinese have been dumping in massive quantities of their mortgage backed securities that were purchased from the U.S. government sponsored enterprises of Freddie Mac and Fannie Mae and replacing them with full faith backed U.S. Treasuary paper. Japan have seized further purchases of U.S. government paper. It appears with China’s continued and ever growing trade surplus, they will continue to purchase U.S. government treasury paper.
In addition, China has indicated that they intend devaluing their currency with respect to the U.S and providing incentives to their export market, effectively trade protection, ala the Chinese style of Smoot-Hawley. This does not at all bode well for the massive trade imbalances that exist. China can not expect the rest of the world to continue to consume their over supply under current circumstances, the Chinese have to restructure their economy away from export production to internal consumption, but this will not happen over night. China may, in fact, come out of this far worse than other countries if they follow policies that attempt to protect their export market, rather than adjusting and allowing the renminbi to appreciate.
So the question is how likely is that bretton-woods will survive?
Thus, carbonsink, as you can see, their are political constraints that come into play when a country thinks that it can merely inflate it’s way out of this predicament.
We are living in extraordinary times and witnessing the end-game of the decline of U.S. financial, military and political hegemony.
The Black Swan begins to appear, and then we begin to live in dangerous times.
Michael, I think you have missed the point of the article, which is that people hold onto their scrip because they found it difficult to obtain more. They will always try to hold enough for their future engagements. Unless they can gain more they wont use them for meals out but only for important functions like weddings. This deprived other people of the chance to obtain scrip. The equivalent function in an economy is that if we need the assurance that we can meet future important commitments like food and housing before spending on less important things like holidays and wide screen TV. Once we are concerned about job security we will hoard money and the economy will stop.
If too much scrip is issued, everybody spends but there is no demand. Why should I do babysitting if I have enough scrip to last me the next 10 years. So again the system stops.
Regarding debt moratoria, if it were ever to be put into effect, it would need to be very carefully crafted so as to only assist home owners, who are first home owners, and the assistance is only to their abode and nothing else. The speculators should be allowed to twist in the wind and get absolutely zip.
Furthermore, there must be a carrot and a stick component to any such policy, that is, the home owners must:
1. demonstrate true hardship conditions;
2. must provide some sort of service back to the community, and I mean something substantial and of value to the community; and
3. have their credit rating adjusted appropriately.
iconoclast,
I am not sure whether you borrowed the 1956 Suez crisis anecdote from the very excellent video “IOUSA”, but whether or no from other sources, it serves to make an excellent point.
And since as others have highlighted, ‘things that we couldn’t have dreamed of a matter of months ago now being our reality”, it does not take too much of a leap of imagination to suggest that if China sought to do to the US, as the US did to Britain/France in 56, then it doesn’t then seem such a long bow to suggest:-
America in panic: – “what do you need China?”
(Don’t read ‘china plate’ = ‘mate’ here – far from it ! )
China (sanguinely stroking beard softly in contemplation)
“We need space (land) and resources (minerals etc)”
America : “We have an old and very strong ally (not so strong these days with the new order and short memories) that has plenty of both those things. We may just be able to influence an invas…. I mean a revised “very liberal ‘immigration policy” (the new government is that way inclined anyway).
China: “What if they object?”
America: “We can point out that it can happen the easy way or the hard way”
China: Confucius would be proud !